FASB ASC 326, current expected credit losses (CECL), is an accounting standard for businesses with trade receivables that required adoption by private entities in 2023. With CECL, if historical experience and future expectations suggest that some receivables or assets will not be collected, the business must immediately recognize an allowance for credit losses, which reduces the assets carrying value with a corresponding impact on earnings.
While there are certainly accounting implications companies should work with their CPAs to understand, the new method has the benefit of helping businesses dig deeper into potential customer relationships and increasing balance sheet transparency.
“Through CECL, businesses can gain new perspective on customers, giving them a broader look into those relationships,” says Alex Ferrara, CPA, MBA, a Senior Manager at Corrigan Krause. “Companies can get more accurate, more timely financials, and a better understanding of accounts receivable balances with all of their customers.”
Smart Business spoke with Ferrara about CECL — what it is, what will change and what insights this new method could open up for businesses.
How can CECL provide more customer insight?
This new standard requires businesses to use more of a predictive model that looks into the future for projected estimated losses from customers. There are a lot of different considerations for that — historical credit losses, the customer payment terms, the industry, the geographic location of customers, etc.
With this model, businesses utilize forecasts to look at a customer’s future expected loss at inception, rather than through the previous GAAP bad debt model. That bad debt model was utilized as a current incurred loss method, where those receivables would be written off when the business deemed it uncollectible. CECL utilizes an allowance for credit losses as an estimation of the outstanding payments that they might not expect to recover. It’s taking adjustments upfront for future losses, rather than waiting to the end when they can’t be collected — for instance, because a customer went bankrupt. This method enables companies to be more proactive and have a better understanding of customers from the moment they’re brought on.
What adjustments should businesses make?
When adjusting for an allowance, it adds an expense to the company’s financial statements, which will drive down profitability. That could impact covenants. That’s why it’s important for the in-house accounting staff and external CPAs to be proactive and communicate to understand how those adjustments might impact financial statements and covenants.
A change in the allowance for credit losses is not tax deductible. If there is just a change in the allowance, it’s deductible on the books. When it’s time to do the tax return for the shareholders, it’s not tax deductible — only when that item is truly written off is it offset against the allowance and gets removed from accounts receivable, and then deducted. So, adjusting for CECL does not allow a tax deduction until that amount is deemed uncollectible and written off as long as it was previously included in taxable income.
When does this take effect?
Any company with GAAP financial statements — typical for businesses that have bank covenants — must follow CECL. There are cash basis and tax-only businesses that can be impacted less by this standard. It should have been adopted with annual financial statements for the calendar year 2023. There were required transition disclosures in the adoption year and recurring annual disclosures to the financial statements.
A minor percent of private businesses were impacted in 2023. That number will continue to increase as it’s more widely implemented and understood since adoption. So, businesses unsure about how this new accounting method will impact them should work with a CPA who has the experience through a range of clients in different industries to help navigate the changes this new accounting standard brings.
It’s important that companies stay ahead of the ever-changing landscape of GAAP accounting. Proactive communication internally with their accounting team and externally with their CPA firm will keep them ahead of the game.
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